invic

The LIBOR yield curve is:

180-days	5.2%
360-days	5.4%

What is the value of a 1-year semiannual-pay LIBOR based receiver swaption (expiring today) on a $10 million 1-year 4.8% swap?

A) $0.

B) $50,712.

C) -$50,712.

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First, find the discount factors. 1/(1+(0.052×(180/360))) = 0.97465887 and 1/(1+(0.054×(360/360))) = 0.94876660 Calculate the market fixed rate payments: (1 - 0.94876660) / (0.97465887 + 0.94876660) = 0.026637 and compare to the exercise rate payments 0.024. The value of the receiver swaption is zero since the exercise rate is below the market rate.

invic

The London Interbank Offered Rate (LIBOR) yield curve is:

• 180-days: 5.2%.
• 360-days: 5.4%.

What is the value of a LIBOR-based payer swaption (expiring today) on a $10 million 1-year 4.8% swap?

A) −$50,712.

B) $0.

C) $50,712.

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• Determine the discount factors.
  
  180 day: 1 / [1 + (0.052 × (180 / 360))] = 0.974659
  360 day: 1 / [1 + (0.054 × (360 / 360))] = 0.948767
• Then, plug as follows:
  
  (1 − 0.9487666) / (0.974659 + 0.9487667) = 0.026637
• The value of the payer swaption is the savings between the exercise rate and the market rate:

(0.026637 − 0.024) × (0.97465887 + 0.9487666) × 10,000,000 = $50,712.

invic

Cal Smart wrote a 90-day receiver swaption on a 1-year LIBOR-based semiannual-pay $10 million swap with an exercise rate of 3.8%. At expiration, the market rate and LIBOR yield curve are:

Fixed rate 3.763%
180-days 3.6%
360-days 3.8%

The payoff to the writer of the receiver swaption at expiration is closest to:

A) $0.

B) -$3,600.

C) $3,600.

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At expiration, the fixed rate is 3.763% which is below the exercise rate of 3.8%. The purchaser of the receiver swaption will exercise the option which allows them to receive a fixed rate of 3.8% from the writer of the option and pay the current rate of 3.763%.
The equivalent of two payments of (0.038 - 0.03763) × (180/360) × (10,000,000) will be made to the receiver swaption. One payment would have been received in 6 months and will be discounted back to the present at the 6-month rate. One payment would have been received in 12 months and will be discounted back to the present at the 12-month rate
The first payment, discounted to the present is (0.038 - 0.03763) × (180/360) × (10,000,000) × ( 1/1.018) = $1,817.28.
The second payment, discounted to the present is (0.038 - 0.03763) × (180/360) × (10,000,000) × ( 1/1.038) = $1,782.27
The total payoff for the writer is -$3,599.55.

invic

Current and potential credit risk in a swap are:

A) not equal at the inception of the swap.

B) equal at all times over the term of a swap.

C) greatest between payment dates.

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Current credit risk is the risk of not receiving a payment currently due, since there is none at the inception of the swap, current credit risk is zero. Potential credit risk is the risk that payments possibly due in the future will not be made.

invic

The credit risk of an interest-rate swap is greatest:

A) just before the final payment must be made.

B) late in the term.

C) at the middle of the term.

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The credit risk in an interest-rate swap is greatest at the middle of the swap.

invic

Which of the following statements related to credit risk during the life of a swap is most accurate:

A) Credit risk is greatest at the beginning of the swap term because there are significant payments yet to be made over the remaining term of the swap.

B) Credit risk is greatest in the middle of the swap term when both the creditworthiness of the counterparty may have deteriorated since swap initiation and there are significant payments yet to be made over the remaining term of the swap. (Study Session 17, LOS 57.i)

C) Credit risk is greatest at the end of the swap term because creditworthiness of the counterparty is likely to have deteriorated since swap initiation.

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Credit risk is greatest in the middle of the swap term when both the creditworthiness of the counterparty may have deteriorated since swap initiation and there are significant payments yet to be made over the remaining term of the swap. (Study Session 17, LOS 57.i)

invic

A swap spread is the difference between:

A) the fixed rate on an interest rate swap and the rate on a Treasury bond of maturity equal to that of the swap.

B) LIBOR and the fixed rate on the swap.

C) the fixed-rate and floating-rate payment rates at the inception of the swap.

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A swap spread is the difference between the fixed rate on an interest rate swap and a Treasury bond of maturity equal to that of the swap.

invic

The swap spread will increase with:

A) an increase in the credit spread embedded in the reference.

B) the variability of interest rates.

C) a deterioration in one party’s credit.

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The swap spread is the spread between the fixed-rate on a market-rate swap and the Treasury rate on a similar maturity note/bond. Since the fixed rate is calculated from the reference rate yield curve, it is increased as the credit spread embedded in the reference rate yield curve increases.

invic

A swap spread depends primarily on the:

A) shape of the reference rate yield curve.

B) general level of credit risk in the overall economy.

C) credit of the parties involved in the swap.

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The swap spread depends primarily on the general level of credit risk in the overall economy.

invic

For an interest rate swap, the swap spread is the difference between the:

A) swap rate and the corresponding Treasury rate.

B) fixed rate and the floating rate in a given period.

C) average fixed rate and the average floating rate over the life of the contract.

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The swap spread is the swap rate minus the corresponding Treasury rate.